Microsoft (MSFT 0.79%) the stock has generated a total return of more than 1,000% over the past 10 years. Most of those gains came after Satya Nadella took over as the tech giant’s third CEO in 2014.
Under Nadella, Microsoft turned its fledgling cloud business into its primary engine of growth. It extended Office and Dynamics as cloud-based services and made Azure the second largest cloud infrastructure platform in the world after Amazon Web Services (AWS). It launched new Surface devices and Xbox consoles and gobbled up other companies to grow its gaming business.
Image source: Microsoft.
Between fiscal year 2014 (which ended in calendar year June) and fiscal year 2021, Microsoft’s annual revenue grew at a compound annual growth rate (CAGR) of 10%, its earnings per share (EPS) increased at a CAGR of 17%. As a percentage of its total revenue, Microsoft’s commercial cloud revenue grew from just 5% in fiscal year 2014 to 41% in fiscal year 2021.
This dramatic transformation breathed new life into Microsoft’s stock, kept it from becoming a tech company as well, and turned it into a $2 trillion company last year. But can Microsoft sustain this momentum over the next decade? Let’s review the bearish and bullish cases to decide.
Why bears think Microsoft stock will stagnate
Bears believe that Microsoft’s business is still exposed to macroeconomic headwinds. It reportedly increased salaries and stock-based compensation for some departments to stave off inflation, but also slowed hiring for its Windows, Office and Teams groups.
These adjustments are not surprising, but indicate that Microsoft may be preparing for slower growth and other macroeconomic challenges this year. Sales of the company’s Xbox Series consoles and Surface devices could also be limited by chip shortages and supply chain constraints.
Microsoft’s planned takeover of ActivisionBlizzard (ATVI 1.06%) for $68.7 billion also raises red flags. Activision is one of the biggest video game publishers in the world, but it’s grappling with slowing growth from its aging franchises and a sexual harassment scandal. The deal still needs to be approved by antitrust regulators, and Microsoft is expected to pay a $3 billion fee if the deal fails.
Buying Activision could bolster Microsoft’s first-party publishing business and add more games to its Xbox Game Pass and Xbox Cloud Gaming platforms. However, he might also bite off more than he can chew.
Microsoft also seems to be falling behind Metaplatforms and Apple in the race to launch augmented reality (AR) devices for consumers. Microsoft established a forerunner advantage in this market with the developer version of HoloLens in 2016, but has yet to launch a cheaper device aimed at consumers. If the AR market suddenly takes off, Microsoft could be left behind on another technology curve, just as it initially botched the transition to smartphones under Steve Ballmer.
Why the Bulls Think Microsoft’s Brightest Days Are Ahead
Wall Street remains extremely bullish on Microsoft. Analysts expect its revenue and adjusted earnings per share (EPS) to increase 19% and 16%, respectively, in fiscal 2022. In fiscal 2023, they expect its revenue to grow 14% as its adjusted EPS grows another 16%. Those are rock-solid growth rates for a stock that trades at just 23 times forward earnings.
Bulls remain confident in Microsoft’s growth prospects as its cloud business is still running at full steam. Azure, the most watched component of this segment, has consistently delivered 40-50% year-over-year revenue growth over the past year. It has also consistently increased its market share over AWS as it attracts more customers, especially brick-and-mortar businesses that don’t want to work with Amazon. Its entire cloud business, which also includes Office and Dynamics, has seen revenue growth of more than 30% in the past year.
Microsoft doesn’t seem too concerned about macro headwinds either. On last quarter’s conference call, Chief Financial Officer Amy Hood said she expects to “close Fiscal 22, even in a more complex macroeconomic environment, with the same consistency we’ve delivered throughout year, with strong revenue growth, market share gains and improved operating margins.” Hood also predicted Microsoft would continue to deliver “healthy double-digit revenue and operating income growth” in fiscal 2023. Satya Nadella also said that even in a challenging macroeconomic environment, most of companies didn’t “look at their IT budgets or digital transformation projects as the place for the cuts.”
Finally, Microsoft has plenty of cash to weather the storm. It ended the last quarter with $104.7 billion in cash, cash equivalents and short-term investments and generated $63.7 billion in free cash flow (FCF) over the past 12 months. It has spent 46% of that total on buybacks and 28% on dividends – and will likely continue to return most of its FCF to its investors.
Strengths outweigh weaknesses
Microsoft may not be completely immune to macro headwinds, but it has rebounded from many economic downturns before. Its gaming and AR strategies are a bit messy, but can easily make up for the mistakes of those smaller divisions with the continued growth of its cloud-based services.
Microsoft shares overheated a bit last year, but they now look much more attractive. Long-term investors should view this as a great opportunity to buy one of the evergreen stocks in the tech sector.
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